Effective Financial Reform
Published: November 29, 2017
Financial crises come from bank runs. An innovative way to prevent bank runs is to use equity-financed banking. Equity-financed banks would replace debt with equity as their method of financing and back up all deposits with liquid assets like Treasury bonds. Since it would not hold any debt, bank runs would become a thing of the past.
Discussion Questions
- Are financial crises inevitable?
- How can equity-financed banking prevent a future financial crisis?
- What makes equity-financed banking more secure?
Additional Resources
- For more, read John Cochrane’s chapter “A Blueprint for Effective Financial Reform” in Blueprint for America.
- You can find the rest of Blueprint for America here.
- For more on equity-financed banking, click here.
- Read John Cochrane blog post “Toward a run-free financial system,” available here.
For a century, our government has tried to prevent financial crises by guaranteeing deposits and regulating risk-taking by banks.
It hasn’t worked.
Banks promise depositors and short-term lenders that they can always get their money out. But banks never have the cash on hand to pay everyone at once, so if there’s ever a run, banks fail.
Lehman Brothers failed, not because its assets were particularly risky, but because it was leveraged thirty-to-one and couldn’t find new lenders to pay off its old ones.
In place of regulations that haven’t worked, we can design a financial system that is immune to crises. Regulators’ current efforts would be rendered irrelevant and obsolete.
An equity-financed bank isn’t susceptible to bank runs because all of its deposits are backed by Treasury bonds or interest paying reserves. There is no short-term debt to worry about.
100% of its money comes from equity. Investors could sell shares to someone else, but couldn’t demand their money back from the bank. Share values might fall, but there wouldn’t be runs resulting in bankruptcy.
Best of all, powerful regulatory bureaucracies would no longer need to dictate how banks invest their money.
Competition would flourish. The politicization of our financial systems in favor of the well connected would become a thing of the past.
Once our government stops subsidizing debt and recognizes that institutions with abundant amounts of capital are safe, banks can be liberated from their regulatory stranglehold.
The result would be a better financial system for all of us.